Author: Joe White

Washington Times – LEESON: The benefits of failure :
LEESON: The benefits of failure
Why we should let some firms go belly up

Peter T. Leeson
Friday, April 3, 2009

In a market economy, business deaths are like death itself – an unfortunate but inevitable fact of life. However, recent government bailouts have tried to stop the inevitable by intervening in the market, at least temporarily saving failed firms from the economic grim reaper. Before putting the next failed business on life support, it’s worth remembering why it makes sense to let struggling producers expire.

• When failing businesses are allowed to fail, resources are released from employments where they don’t add value and made available for employments where they do.

Resources used for one purpose can’t be used for another. Thus, it’s important that they find their way to the purposes we value most. Enter the profit-and-loss system. Under this system, when producers use resources in ways that are consistent with our wants, they earn profits. When they don’t, they earn losses. If losses are severe enough or accumulate over time, the producers who earn them go under.

Far from cause for concern, this failure is cause for celebration. When ineffective producers fail, resources committed to producing goods we value less are freed for producing goods we value more. Polaroid’s failure released resources for the production of digital cameras; Commodore Computers’ failure released resources for the production of IBM computers; and Chi Chi’s restaurant’s failure released resources for, well, the production of food that tastes good. Who better to sacrifice the resources required to expand production of the things we want than producers of the things we don’t?

If government prevents failing producers from going out of business, resources get “stuck” in employments where they’re less productive. We can’t have as many of the products we care more about because the means needed to make them remain locked in the manufacture of products we care less about. Society suffers as a result.

• When failing businesses are allowed to fail, producers learn how to combine resources in ways that create wealth.

We take it for granted that producers know what we want. But this information doesn’t appear magically. It has to be produced. The profit-and-loss system produces this information – but only when government lets failing businesses fail.

Profits and losses do for producers what traffic signals do for drivers. They tell them when to “go,” “slow down” and “stop” their productive activities. By communicating which resource combinations consumers value most and which they don’t, profits and losses direct “economic traffic,” informing producers how to produce.

If government prevents ineffective producers from failing, the red light on the “economic traffic signal” stops working. Production continues and resources flow when they should halt, destroying wealth instead of creating it.

• When failing businesses are allowed to fail, producers have incentives to combine resources in ways that create wealth.

The profit-and-loss system works because successful producers reap rewards when they combine resources effectively and unsuccessful producers incur costs when they don’t. The prospect of profits from making good decisions and losses from making bad ones encourages producers to make choices that improve our lives.

But if government shields ineffective producers from the consequences of their bad decisions, producers’ incentives become skewed. For instance, when policy permits producers to enjoy the benefits of successful risk-taking but subsidizes the losses of unsuccessful gambles, producers have an incentive to take on more risk than they should. Since they’re no longer responsible to consumers when they make poor choices, the link connecting producers’ and consumers’ interests is weakened and, with it, the economy’s ability to advance.

At a time when failure is the new dirty word and government seems willing to prop up floundering firms at any cost, we would do well to remember the benefits of letting failing businesses go belly up.

Peter T. Leeson is BB&T Professor for the Study of Capitalism at George Mason University and author of the new book, “The Invisible Hook: The Hidden Economics of Pirates.”.

We Are Very Concerned About the Anger We’re Fomenting, by Matt Welch (Reason: Hit & Run):

I suspect that what the administration might really be worried about is that there’s a glaring contradiction at the intersection of its messaging and policy. Officials talk like they’re really gonna stick it to AIG this time, then they ladle out another $20 billion. You want to punish a banker or a Wall Street executive? Let his company fail. And if he’s broken the law, prosecute him.

“Penny-wise, pound-foolish” comes to mind. But whereas there were 240 pence in the old pound, it is pretty sad that the “penny” of this story – $165 million – is much less than 1/240 of the $85 billion that has been handed to them already, and unfortunately, not likely the last.

Inappropriate Stimulation, by Mario Rizzo at ThinkMarkets:

What is happening is a massive re-allocation of resources mainly due to the excessively low interest rate policy of the past few years – but also partly due to certain sectoral shifts. The American car manufacturers, for example, are suffering both from the contraction in credit and from their own long-term inefficiencies.

The fiscal stimulus program is designed to stimulate where economic activity has deteriorated and there are job losses. Many of these areas are those that had over-expanded. As we have been saying for some time on the blog, the effect of this kind of stimulation is to slow down the re-allocation of resources. It will not succeed, however, in preventing it. What it will do is prolong the recession.

LET THEM FAIL (by Russell Roberts):

We’re going to run out of money.

We can’t keep GM and AIG and Fannie and Freddie and every insolvent bank and every mortgage afloat. It can’t be done. It’s not a strategy. It’s just desperation to avoid pain.

We’re going to have to start letting them fail.

Sooner is better than later. Otherwise, we continue to throw good money after bad.

Let them fail.

When you’re in a hole, the first lesson is to stop digging. Let’s start by putting down the shovel and admitting we are heading in the wrong direction.

Let’s taste some bankruptcy. Let’s let some resources and capital get out of the hands of the people who are misusing it and into the hands of people who can use it more productively, wisely, and prudently.

All Hail the Mighty State: Texas Independence Day:

173 years ago, George C. Childress hurriedly composed a document at Washington-on-the-Brazos while only 150 miles away, the Alamo was under a brutal and ultimately fatal attack by the Mexican army. The document, which was written overnight at a hastily formed convention of Texas leaders, accused the Mexican goverment of ceasing to protect the lives, liberty, and property of the people of Texas. It became the Texas Declaration of Independence.

…the people of Texas do now constitute a free, Sovereign, and independent republic, and are fully invested with all the rights and attributes which properly belong to independent nations; and, conscious of the rectitude of our intentions, we fearlessly and confidently commit the issue to the decision of the Supreme arbiter of the destinies of nations.

And with those words, the people of the Republic of Texas declared independence from Mexico on this day, March 2, 1836.

The Texas War of Independence had begun half a year earlier, on October 5, 1835, with the defeat of the Mexican army at the Battle of Gonzales by armed Texians who refused to surrender a cannon – the famous “Come and Take It” cannon – to the Mexican government, as it was their only means of protection against Indian attacks on the settlement.

General Antonio López de Santa Anna, the recently-elected president of Mexico, had just the year before abolished the Constitution of 1824 – which very loosely governed Mexican territories, including Texas – and enacted a harsh, anti-federalist constitution in its place. The new constitution took away liberties to which most Texian settlers had become accustomed, required that they convert to Catholicism, tithe 10% of their earnings to the Roman Catholic church and created the state of Coahuila y Tejas out of the former territory, with its new capital hundreds of miles away from the former capital of San Antonio. Texian settlers were furious.

After winning the Battle of Gonzales, local leader Stephen F. Austin began to round up volunteers to form a Texian Army, much to the fury of General Santa Anna. They saw their first great victory at the Siege of Bexar on December 11, 1835, defeating the Mexican army and General Santa Anna’s own brother-in-law, General Martin Perfecto de Cos, despite being outnumbered two to one and having very little ammunition or training.

The War of Indpendence reached a fever pitch at the infamous Battle of the Alamo, where General Santa Anna himself led an offensive on the Texian army members who were garrisoned at the Alamo, a former mission in San Antonio that was being used as a military headquarters. Between February 23 and March 6, 1836, the small number of Texians inside fortified the Alamo and were able to hold off the waves of Mexican troops. Ultimately outnumbered by twelve to one, the Texians were finally slaughtered – including the famous Davy Crockett, William B. Travis, James Fannin and Jim Bowie – and only a handful of survivors were allowed to leave the destroyed mission. Susanna Dickinson was spared by General Santa Anna so that she could spread the word of the defeat to her fellow Texians.

The defeat didn’t have its intended effect, as the defiant cry “Remember the Alamo!” was used to rally the Texian army during what would be the final battle of the Texas Revolution: the Battle of San Jacinto. The revolution came to an end here in Houston in a short, vicious battle. Although lasting only 18 minutes, over 600 Mexican troops were killed by an army of 900 Texians and two cannons. General Santa Anna escaped from the lost battle that day, April 21, 1836, and formally surrendered after being hunted down by a search party (who recognized the president in part due to the fancy silk underwear he was wearing).

A month later, the Treaty of Velasco was signed by General Santa Anna and David G. Burnet (the interim president of the Republic of Texas, prior to Sam Houston taking the reins) at what is now Surfside Beach. The treaty formally ended the Texas Revolution and recognized the Republic of Texas as a sovereign nation. The Republic existed as an independent nation for ten years before being annexed by the United States as the 28th state in the union.

And while it’s not entirely true that Texas retains the right to split into five separate states at any time (really, any state can split if it wants to) and it’s not at all true that Texas retains the right to secede from the United States at any time, one important thing is true (aside from the fact that the federal government has no control over our land or oil reserves; only our state goverment does!): Texans are strong, proud people who fight for what they believe in.

Happy Texas Indepdence Day, y’all!

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Photos courtesy of Flickr users kshilcutt, aggiechristine and R&R Finn.